Thomas Piketty’s Capital in the 21st Century was finally released in English last Monday. It’s been hailed by many as one of those once-in-a-decade game changing books. Needless to say, I am very excited to read it. I’ve only read through the first fifty pages but the basic arguments are clear and already fascinating.

A narrative of economic development prominent today is that inequality is efficient (to an extent) and decreasing. Simon Kuznets observed in the middle of the twentieth century that in developed countries income inequality was decreasing and incomes were converging. He made it clear that this was only a correlation and he gave no declaration that this was inevitable or sustainable. Nonetheless, incomes were converging and many took this to be the beauty of capitalism: inequality may exist for a while but in the end we’re all better off.

In fact, convergence happened a century before. As the Industrial Revolution steadily expanded in the early 19th century, the vast majority of workers saw stagnant or falling wages next to exploding incomes of capital-owning individuals. David Ricardo and Karl Marx separately predicted different doomsday scenarios of a massive scarcity of land causing an unhealthy concentration of wealth and spiraling returns to capital causing a global revolution, respectively. Of course, neither apocalypse happened. In the last third of the 19th century, low-income individuals saw their wages rise, even if it occurred with massively increasing inequality.

Inequality increased in the roaring 20s until the Great Depression and World War II. From the time of these events until the early 1970s, income inequality decreased in most developed countries. The prevailing wisdom was that high inequality was followed by converging incomes in the natural progression of economic development.

What Piketty aims to drive home is that this convergence was the exception, not the rule. The Great Depression and Second World War caused the fortunes of the capitalists to implode. In fact, the financial crisis of late initially decreased inequality mostly because the rich had more to lose. After World War II, he argues, American policy was set up to reward broadly distributed growth instead of growth aimed at rewarding capitalists. Then, Reagan and Thatcher won and it was reversed. I should note here that Piketty is French, has been a member of the Socialist Party, and by virtue of being an inequality economist comes with certain biases. His points are largely data-driven but do need to be placed in the context of his background.

The fundamental identity he proposes in the book is that when r > g capitalism will breed unsustainable inequality. r is the rate of return on capital and g is economic growth. When the return to capital is bigger than the rate of economic growth, wealth accumulates in a concentrated set of hands. When an economy is slow-growing, past accumulated wealth has growing importance. Inequality is thus bound to increase and continue to do so. Developed economies have slowed since 1973 and r is becoming greater than g, in the eyes of Piketty. Further, g includes population growth and this has been close to zero in many countries. As he promises to show in later chapters, this identity need not be necessary. Policy can help change this to prevent a revolution or massive conflicts Ricardo and Marx once predicted.

I find the premises presented so far to be interesting for a number of reasons. One is that Piketty admits this divergence is not the result of any market failures. Rather, he finds the more perfect the capital market the more inequality a country will have. Second, I have always assumed a convergence of incomes in economic progress or, at the very least, figured that increasing inequality can be forgiven as long as everyone is better off in absolute terms. If this is not the natural path of capitalism, we are all in for a surprise of hurt. And third, a few writers have posited that we are in a Second Machine Age much like the first industrial revolution, where wages may stagnate now but eventually they will rise. Whereas the first industrial revolution replaced brawn with machines, now we are replacing brains. The gains from this may be realized by the masses eventually, but there could be a very rough transition period. I hope to see how Piketty addresses this and how fatalistic he sees a spiraling inequality.

Inequality is increasingly becoming a hot topic lately. I find the way it’s framed in popular discussion to be somewhat nauseating. The two sides tends to present totally incomplete stories that do nothing but perpetuate preconceived notions of class and how people get the incomes they do.

On the right, you have the general perspective that people get the wealth they deserve. Sure, people get some bad breaks, some are born with better genes than others, some have to overcome great obstacles. But in general people end up with a fate significantly related to their work ethic and decision-making. Broadly speaking, wealth inequality isn’t as much of a problem to people on the right because it reflects a difference in contributed value between those at the top of the distribution and those at the bottom. Trying to decrease inequality, then, would be inefficient and unjust since you’d merely be redistributing resources from the productive to the less productive, disincentivizing hard-earned productive work and rewarding unproductive work.

On the left, the general perspective is that rising wealth inequality is the result of people manipulating the system. Rich people are rich because they figured out how to play the game. They were given some opportunities often not presented to others and used it to extract more and more money out of the market. Redistribution is thus justified because the rich aren’t rich because they have provided anything great, nor did they ever really deserve the money in the first place.

These are two polar opposites of the spectrum, but popular commentary tends to take one side of this spectrum without giving much credence to the other side. It is because of this that I find the discussion about inequality is not a discussion at all. It’s two sides talking over each other. Some on the right hear an argument on the left and dismiss it altogether because there’s no acknowledgement of an ethos of hard work nor that many of wealthiest create things that clearly benefit the masses. Some on the left hear an argument on the right and the oversimplification of “hard work > wealth” without any mentioning of significant hurdles and dismiss anything they have to say.

The reality is that a new wealth of economic literature points to an explanation for rising inequality compatible with these points of view and yet suggesting completely different solutions.

A couple decades ago, the idea of the “Economics of Superstars” came to being. Basically, the top 1% of any profession was starting to get a larger share of the industry. It wasn’t just the 1% – I say that proverbially, when I really just mean the distribution is slanted more to the top – of bankers, lawyers, or anyone that tends to be vilified by class warfare. It was dentists, musicians, drug dealers, accountants. Literature shows this change across all professions.

The two strongest explanations for it are technology and globalization. The easiest way to frame it is this: Homer could only tell his stories to 50 people in a night, Shakespeare could only fit a few thousand people in a theater, JK Rowling can sell her books to 7 billion people. A gladiator could perform in front of tens of thousands of people at most at a time, Babe Ruth could perform for tens of thousands and then some because of radio and people reading newspapers, Michael Jordan could perform in front of billions because of television. In each of these cases, the top performer’s audience was enhanced by technology and the emergence of a globalized economy.

The demand for “the best” was satisfied because of the actual ability to be able to get the best. Before, any profession was competing locally or regionally. Now, we compete globally. The best x in the Chicagoland area used to just have to compete with people in Chicago, or maybe just in their neighborhood. Now, the best in Chicago has to compete with the best in London, Dubai, and Sydney. This makes “the best” have a lot more demand in the market. The very slight marginal difference between LeBron James and Kevin Durant is amplified by this globalization and makes LeBron the global icon he is.

You’d rather have the best surgeon doing your heart surgery than the second and third best put together. That’s why the best can demand so much more money. It’s not always clear who “the best is” especially when it comes to subjective entertainment like music, but these mechanisms are still present. Beyonce makes more than Bach ever did not only because of a higher global population that has more money, but because she’s able to reach the audience. The “best” these days might not necessarily be better than “the best” in a less globalized economy. They just have better means to showcase their skills.

The solution I always read in this literature is higher progressive taxation. I’m not convinced. Doing this does nothing to change the roots of the problem. Any solution is particularly tricky because we don’t really want technology to regress nor globalization to stop. And to those who say we should stop globalization, I’ll just say I think it’s impossible. Progressive taxes might increase opportunity and class mobility, but none of this research ever mentions at what point progressive taxation becomes too much. Until I see a convincing analysis of this, I will remain skeptical.

So my take on increasing inequality is different than both of the polar extremes yet still compatible with some of their points. Inequality is not the result of an extra manipulation of the market by the 1%, nor is it purely because of extra hard work from the best of the best. It is instead a result of the changing dynamics of a global labor market. Overall I believe this shift is something to be concerned about because at some point inequality because inefficient, decreased class mobility is against whatever version of social justice most believe in, and there is evidence that it creates credit bubbles as the middle class tries to maintain higher consumption.

However, the rich are not to be vilified for their newly increased wealth. The fact that JK Rowling’s books can reach a global audience should be celebrated. People all over the world have much more access and choice to the music they hear and the movies they watch because of these changing dynamics. This technology and globalization has its plusses and certainly its often more visible minuses. But before oversimplifying the issue as hard work vs manipulation, think about the how the world is changing rather than trying to place blame.

I’ve noticed that a lot of people who only have a fairly passing familiarity with political philosophy think that John Rawls is a lot more radically egalitarian than he actually is (For example, here‘s the first crazy looking misrepresentation of Rawls I found in a Google search [the author claims to have an MA and Ph.D; I think it’s safe to assume that neither of those are in philosophy]). Perhaps the cause of this distortion is the way Rawls and Nozick are commonly put forth as representing the two main sides in the modern distributive justice debate, with Rawls on the left and Nozick on the right.

In light of this confusion, it’s important to emphasize how un-radical Rawls’s view is (a fact that gets Rawls a lot of heat from philosophers who are actually leftist).  It’s the second half of Rawls’s second principle of justice, the Difference Principle, that is at the root of a lot of confusion about his views:  “Social and economic inequalities are to be to the greatest benefit of the least-advantaged members of society” (JF, 42-43).  As I was just reading the Rawls entry on the Stanford Encyclopedia of Philosophy, I came across this helpful chart:

Economy Least-Advantaged Group Middle Group Most-Advantaged Group
A 10,000 10,000 10,000
B 12,000 15,000 20,000
C 20,000 30,000 50,000
D 17,000 50,000 100,000

The difference principle, according to the article, “selects Economy C, because it contains the distribution where the least-advantaged group does best”.  In fact, to find out which distribution the difference principle would choose, you don’t even have to be able to see the last two columns.  The difference principle focuses only on the disadvantaged, and does not make any judgment at all about how much the wealthy should have compared to the least well off.  The are plenty of interesting and legitimate objections that one can make to the difference principle, of course, but I think that most people tend to greatly overestimate the extent to which it is egalitarian.

Mark Thoma recently linked to an interesting piece discussing why some countries have higher social mobility than others.

As I’ve written before, I think that people are wrong to focus on relative wealth (aka inequality) than absolute wealth (aka improved standards of living). However, the element of social mobility is relevant, as it signals in a sense how much income is decided by factors like hard work and how much income is decided by factors like personal connections, having a large trust fund, etc.

The United States, perhaps unsurprisingly, is grouped with countries like the United Kingdom, France, and Italy as places with relatively low class mobility compared to countries like Denmark, Norway, and Canada.

But before we write off capitalism and trump huge Scandinavian welfare states, we need to look more into the study. Causa and Johansson, the authors of one study mentioned, found:

Across European OECD countries covered by the analysis there is a substantial wage premium associated with growing up in a higher-educated family, whereas there is a penalty with growing up in a less-educated family, even after controlling for a number of individual characteristics.

I am willing to accept that the horrible state of education – especially in lower-income parts – in America plays a large part in decreased social mobility. But it’s not for lack of effort. The United States does not lag these countries in education spending. In fact, America spends a tremendously larger amount, both in absolute terms and per GDP per capita, than the countries that have higher social mobility.

Some other findings also conclude that egalitarian governmental programs do indeed increase social mobility. Check out the post here.

After receiving a few not-on-the-blog comments, I guess I should elaborate more on my previous post on income inequality.

First of all, I am aware that no everyone that tries to lessen income inequality does it for economic reasons. A good argument can be made that income inequality can cause political disenfranchisement and even discouragement to lower-income workers. Both are true, but I believe are overstated.

Another thing I forgot to mention is that inequality can have a positive effect on lower-income groups. It sounds silly, I know. However, I definitely see the logic behind such arguments. As a student of economics, I am inclined to see all actions guided by incentives, aka personal desire to maximize utility. Income inequality can act as a positive incentive in two ways to improve the conditions of the poor.

First, a gap between the rich and poor gives the poor an incentive to do something like go to college and increase their human capital. If the income difference between going to college and not going to college was very small, people would be less inclined to take 4 years (or more) off from working to make themselves more valuable to the marketplace. If fewer people are going to college, all of society suffers because good education has positive externalities.

Secondly, the gap between the rich and poor offers positive incentives for rich people. If people were limited to how wealthy they could become, they’d do things like not work overtime or put in that extra time to come up with some great new invention. Thus, the upper bound of the rich-poor gap motivates the most productive of society to fulfill their potential.

I understand that both of the reasons I just gave are based on the premise that people are motivated only by money and that without it they won’t do anything. It’s a broad conception of reality, I know. But it still has a lot of truth to it.

Egalitarians often point to wealth inequality as a sign that society is not doing enough to improve the conditions of the poorest. But inequality and standard of living are completely different and should be treated as two separate issues.

I remember in my AP political science class we were told that psychology tests proved that people – despite what they believed – were more concerned about relative wealth than absolute wealth. In other words, picture these two situations: I get $40 and you get $70 in situation A. In situation B, I get $30 and you get $45. In Situation A, we both have more money. We are both wealthier in absolute terms. In situation B, the inequality of our respective wealths is less, but our absolute wealth is lower; on the other hand, my relative wealth is better in B than in situation A.

I think – or at least I hope – that we all can agree that situation A is a preferred outcome, since both of us have more money which means a better standard of living (in the material sense).

One of the biggest fallacies about economics is that it is a zero-sum game. What I mean by this is that if I become ten dollars richer, I have taken it away from someone else. In other words, Bill Gates having X billions of dollars means that we are X billions of dollars poorer. Au contraire!

Market economies thrive on quite the opposite; the total amount of wealth in society is never a fixed amount. The idea is, at least in theory, that instead of artificially redistributing the “slices of pie,” making “the pie” bigger is a better way to help the worst-off in society (as Rawls himself even admitted). History, I believe, is on my side when comparing capitalism with extreme socialism or communism: the poor in the Soviet Union, East Germany, North Korea, or any African socialist utopia are much worse off than in America. In the last few decades, China and India have lifted hundreds of millions of people out of poverty by embracing market reforms. At the same time, wealth inequality has increased. Shouldn’t that be considered a necessary evil instead of something to combat, at the possible expense of further growth?

In my internship this summer for an education think tank, I remember reading a great piece (though I can’t find it now) arguing that achievement gaps shouldn’t be considered as much as proficiency gaps between races/income groups. In other words, instead of caring about the difference in test scores between rich kids and poor kids, we should just be making sure that every child is proficient in all the necessary areas. Caring about the achievement gap can create a false sense of progress, as Carson noted in a previous post, because if the best-off people actually decrease their well-being the inequality has gone down without actually improving the standard of living for the worst-off.

Ok, so that’s my first point: absolute wealth should be considered over relative wealth. But the measurements by which we look at inequality also need to be reconsidered. Will Wilkinson recently wrote an excellent paper questioning the often-reported rise inequality in the United States, saying that, among other things:

  1. The level of real economic inequality is lower than popular treatments of the issue have led many of us to think.
  2. The level of economic inequality is an unreliable indicator of a society’s justice or injustice.
  3. Inequality distracts us from real injustices that are given too little attention.

Check it out if you’ve got time.

An example of a pie that can represent wealth distribution

An example of a pie that can represent wealth distribution